More than 43 million Americans will see their student loan debt partially or completely forgiven under President Biden’s student loan relief plan. For most, this gift will arrive tax-free. But for those residing in a handful of states, their state income tax bills might be several hundred dollars higher, and their state coffers several hundred million dollars richer.
Under federal income tax law, debt discharges, including student loan forgiveness, are generally treated as income. The American Rescue Plan Act, enacted in March 2021, added a little-noticed exception for student loans discharged between January 2021 and December 2024. (Section 108 of the tax code delineates certain other exceptions, such as bankruptcy.)
Most states that levy an individual income tax conform to the current federal definition of taxable income. In such states, President Biden’s loan forgiveness will not be subject to state income tax. However, seven states have the option to break with the federal tax treatment of discharged student loan debt and weigh the resulting consequences for both taxpayers and state revenues.
Indiana, Minnesota, Mississippi, and North Carolina have already announced plans to include debt forgiveness in their state income tax bases. Debtholders in Arkansas, California, and Wisconsin await decisions from state lawmakers or revenue department officials on the issue. (See Figure 1.)
The Department of Education Federal Student Aid Office reports that 8.4 million individuals in these seven states hold $306 billion in outstanding federal student loan debt. Given the limits on the maximum allowable debt forgiveness per person and income limitations on the policy, we estimate that $92.9 billion of student loan debt held by 8.1 million borrowers is eligible for forgiveness.
A total of $4.8 billion in state tax revenues is possible if all seven states choose to treat student loan forgiveness as income. The four states that have already decided to tax this income will raise $1.9 billion in revenue, and California stands to raise $2.2 billion if it makes the same choice. Figure 2 reports the potential revenue gain relative to each state’s 2021 individual income tax collections and general revenues. The variation in results between states is a function of the magnitude of eligible loans and state tax parameters.
States could raise between 0.9 percent (California) and 2.6 percent (Mississippi) of last year’s general revenues and between 1.3 percent (California) and 7.9 percent (Mississippi) of last year’s income tax revenues.
The data used for this analysis are from several sources. Outstanding loan balances by state are from the Department of Education’s Federal Student Loan Portfolio. Eligibility rates are constructed from the 2019 Survey of Consumer Finances data. State tax parameters are from the National Bureau of Economic Research’s TAXSIM model, with adjustments made for 2022 law changes in Arkansas, Mississippi, and North Carolina. There is some uncertainty in these estimates related to limits in the available data on the number and distribution of Pell Grants. We use state-residence-level data on federal direct subsidized and unsubsidized student loan borrowers from the National Postsecondary Student Aid Study (NPSAS) to distribute Pell Grant recipients. Our calculations from the NPSAS data are similar to a White House estimate that Pell Grant recipients make up more than 60 percent of the national borrower population.
In a forthcoming piece, we will consider the effects of forgiveness on borrowers’ 2022 state tax liabilities. Several media reports have calculated borrowers’ maximum possible tax increases based on states’ highest tax rates. In an effort to provide more detail, we will present distributional estimates of the average state tax change by adjusted gross income for average borrowers.
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